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Thursday, 19 September 2013

No taper - see you later!

Markets were poised yesterday for an announcement by the US Federal Reserve that the speed at which they are flushing the market with new money will be gradually slowed down from the current rate of USD 85 billion each month.

This initiative technically referred to as QE (quantitative easing) aims to keep long term interest low to promote investment and housing recovery. As the US economy is clearly recovering without gaining momentum, the market was expecting a gradual withdrawal of this monetary accommodation so much so the the market in the last few weeks drove up the 10 year Treasury rate from 2.5% to just under 3%.

The Fed surprised most when it decided not to taper just yet, and sent a signal that it may do so later. In communicating its reason the Fed, apart from signalling its concern that the recovery lacks momentum, argued that the increase in 10 year rate was premature and tapering now would risk pushing this rate up further suffocating the recovery especially in the housing sector.

The Fed is taunting the market. If you push the 10 year rate up beyond what the recovery requires to gain momentum, it will keep flushing money to put the rate back down.

This decision has consequences beyond America's shores. The first consequence was a sharp drop on the US$ value on the exchange markets including the Euro which is now back to nearly $1.36, close to the high of $1.37 of last January/February.

This is what the European recovery absolutely does not need. We need a lower Euro to give a chance to economies in distress to become competitive on world markets. A hardening of the Euro on the exchange markets neutralises the gains made by the austerity sacrifices and makes the hill yet to climb steeper.

Perhaps it is time for the ECB to consider verbal intervention to keep the Euro in check. If this does not work than it will have to seriously consider whether it makes sense to keep sanity by refusing QE when all around it are going mad.